Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

The Fed juices the stock market in four ways.

To understand how broadly this is misunderstood, consider the following bullet points from a Seeking Alpha (The Fed is not Juicing the Stock Market):

  • It makes for a great headline, but the Fed is not the cause of this rally.
  • Every dollar the Fed has pumped into the economy is spoken for, and it is not in equities.
  • The truth is a lot more boring and scary than the conspiracy theory.

After explaining how the Fed is not culpable for rising stock prices, the author ends the article with the following challenge:

So please, I invite anyone to explain to me, like I was a 5-year-old, what exactly is the mechanism that explains “the Fed is juicing the market," when we know exactly where all the Fed’s money is, and we know that it isn’t in the market.

I am always up for a challenge.

Draining the asset pool

The Fed conducts monetary policy by governing the Fed funds rate. To do this, it buys and sells Treasury securities via open market operations. When the Fed wants to lower rates, it buys Treasury debt. In doing so, it reduces the supply of investible debt, making remaining debt more expensive (lower yield). It most often buys or sells short-term Treasury Bills to affect the short-term Fed funds rate. Open market operations also add or drain the banking system's liquidity to help further hit its target.